Changes in the Monthly Payment: Are You Ready for Them?
OK, so we've covered all the important loan tracks. Now let's go deeper and get our heads around the full complexity of combining them.
As mentioned, except for one loan track — the fixed unlinked track (KALATZ) — all of our other loans depend on an external parameter. That is, the fixed CPI-linked track (KATZ) is linked to the Consumer Price Index (CPI), the interest rate of the variable rate loan unlinked CPI (MALATZ) track is linked to the Israeli Government bond anchor for various terms, and so on. If you missed these nuances, you can read about the various loan tracks.
The most important thing when building a mortgage mixture isn't what the payment will be in the first month, but what the payments will be down the road. You'll probably manage the first month's payment — otherwise the bank wouldn't have approved the mortgage and you wouldn't have taken it out. But will you manage the payments after ten years? Twenty? To explore the future payments across different mortgage mixtures, use our mortgage calculator.
But why should anything change at all? Why should the payment in year ten (payment number one hundred and twenty) differ from the payment in the first month? Because, as we said earlier, the loans are linked to economic variables. We're now planning a mortgage mixture that has uncertainty baked into it, and we'll have to decide how to handle that uncertainty.
There are three approaches you can take when dealing with index changes. Every one of the thousands of people we've spoken with to date follows one of them. Let's get to know each a little better.
Ignoring changes in inflation, the prime rate, and the variable-track anchors — "Abu Ali"
Some people ignore the possibility of changes in the economic parameters that drive inflation. They argue, with some justification, that there's no way to predict what these variables will do in three years — let alone thirty. Nobody has a crystal ball, nobody's a prophet, so the whole idea of using economic models is foolish. Changes in the monthly payment? Since nobody can predict them, let's just ignore them.
On the face of it, such an "Abu Ali" has a very simple mortgage mixture to take: one third prime-linked, one third fixed CPI-linked (KATZ), and one third variable CPI-linked every five years. This is the cheapest mortgage mixture, meaning the monthly payment is the lowest relative to the mortgage amount he'll need.
But it's also the riskiest payment, because if inflation, the prime rate, and the variable-track anchors do change after all, his payment is going to shoot up. There's a simpler word for this: a gamble. "Abu Ali" is gambling with his mortgage, his home, and his family.
Here's an example for you. Look at what happened to inflation over the last twenty years. Stable and static it is not. On top of that, the Bank of Israel has inflation targets it has to meet — it wants annual inflation to stay within a band of 1% to 3%.
Inflation in Israel — one-year trailing view
Overweighting risks — "The Pessimist"
The pessimist is convinced that the worst will happen precisely on his watch. He expects that the moment he signs the mortgage, inflation will jump and lock in at 5% a year and the prime rate will surge to 17%.
Someone who takes this approach will seek minimal — bordering on zero — exposure to risk. One hundred percent fixed unlinked (KALATZ) isn't a dirty word to him. He's willing to pay the price to buy certainty. His thinking is all about the mortgage and how to minimize risk.
The fear of mortgage risk is natural, for exactly the reason Kahneman describes in "Thinking, Fast and Slow": our brain tends to amplify rare probabilities and give them too much weight. That's why so many people picture extreme scenarios — runaway inflation, a market crash, a sharp rise in interest rates — as if they're right around the corner. In reality, this bias leads us to seek excessive protection against risks that feel bigger than they really are. Recognizing that this reaction is natural but not always accurate lets you manage mortgage decisions calmly and deliberately.
Thinking, Fast and Slow — Daniel Kahneman
Chapter 30 — Rare Events.
A safe mortgage comes at a price — it's a more expensive, longer mortgage. People who choose stability will pay hundreds of thousands of NIS more for this insurance policy.
The Smart and Calculated Borrower
So the truth lies somewhere in the middle. We shouldn't bury our heads in the sand, but we shouldn't start building a nuclear bunker either. Sure, the odds of any single assumption we make coming true exactly are basically zero. But we treat these models as a means of risk management. We assume changes in inflation, in the prime rate, and in the government bond anchors, because making no assumptions about them is itself an assumption — a wildly optimistic one that could cost us dearly.
So what will inflation be over the next thirty years?
The path to building a mortgage mixture runs through defining our expectations and assumptions for the economic variables, so now we really do need to decide what they'll be. We'll need to answer the following four questions, which in practice define the changes in the monthly payment:
- What do we expect inflation to be each month?
- What do we expect the prime rate to be each month?
- What do we expect the real and nominal government bond anchors to be in five years, ten years, fifteen years, and so on...